Current Trends in Directors & Officers Liability Current Trends in Directors & Officers Liability February 27, 2006

Agenda The D&O Market: Back to the Future Claim Trends: The Best of Times, The Worst of Times D&O Grows Up: The Day After Tomorrow D&O Crisis Management Planning: Preparing for Barbarians at the Gate

The D&O Market: Back to the Future Determining market capacity: what’s available ($1.4 billion) versus what’s really available ($400 million to $800 million) What factors are driving the pricing of capacity? How is the reinsurance market affecting pricing, capacity and coverage?

What is the impact of reserve changes upon the D&O market? Why have CLASH events taken on new meaning for D&O insurers? How are D&O insurers evaluating their exposure to attachment point? How does the structure (layered, quota share, size of blocks) impact pricing and claims handling? The D&O Market: Back to the Future

Key terms and conditions: severability; the dishonesty/fraud and other conduct exclusions; and rescission The rapid growth of A-Side coverage in its various forms If the underwriting of D&O coverage has not changed, then is the current market really less volatile than it was in 1986? The D&O Market: Back to the Future

Schedule P – “Other Liability” Claims Made Leading D&O Liability Insurers Statutory Gross Accident Year Combined Ratio (Assumes 23% Expense Ratio for All Companies) Source: A.M. Best, CFRA

Claim Trends: The Best of Times Number of Securities Lawsuits fell 17% in 2005 (from 213 in 2004 to 176 in 2005) Market capitalization losses plummeted 33% (from $147 billion in 2004 to $99 billion in 2005) The impact of Sarbanes-Oxley and lower stock market volatility are cited as explanatory factors for these results

The Dura Pharmaceuticals, Inc. v. Broudo decision: The U.S. Supreme Court weighs in on “loss causation” in securities claims In re: Walt Disney Company Derivative Litigation: The Delaware Chancery Court reaffirms the Business Judgment rule Claim Trends: The Best of Times

Big is big more often: the number of settlements over $100 million increased from 2.4% before Enron to 3.9% after Enron collapses The average settlement increased from $26.4 million in 2004 to $28.5 million in 2005 (Cornerstone Research) – these figures exclude Enron and WorldCom settlements Claim Trends: The Worst of Times

The median settlement increased from $6.3 million in 2004 to $7.5 million in 2005 (Cornerstone Research) Financial restatement cases nearly doubled to account for 40% of all cases in 2005 Institutional plaintiffs led 35% of all settlements in 2005 – this compares to only 20% in 2004 Claim Trends: The Worst of Times

Companies paid more than $9.6 billion in settlements with shareholders in 2005 The rise of the individual, opt-out institutional shareholder makes a global settlement that much more difficult to accomplish Claim Trends: The Worst of Times

D&O Grows Up: The Day After Tomorrow The insurance industry is entering a period of transformation Volatility in the D&O market frustrates policyholders, underwriters, reinsurers and brokers The lack of differentiation in the commercial market frustrates many policyholders Approximately 2% of publicly-traded companies are sued for securities-related claims in any given year Why do so many companies have to pay for the sins of so few?

We know a lot about what causes D&O shareholder litigation Risk modeling and predictive analytics require sufficient quantities of financial, governance and loss data The data is available The challenge is figuring out how to use the data to answer the right questions about D&O liability risk prevention, mitigation and transfer D&O Grows Up: The Day After Tomorrow

Risk Modeling Business Effectiveness Governance Practices Accrual Practices Firm Descriptors Regulatory Forces(e.g., Sarbanes-Oxley) Market Forces(e.g., premium levels) Firm-Controllable Factors Risk Profile Class Action Litigation Likelihood Expected Loss

Risk Quantification: Likelihood & Severity Firm-specific class action likelihood will be quantified as a step toward risk assessment Firm-specific probabilities will be computed relative to industry giving rise to likelihood level groupings defined vis-à-vis industry average Not actual results--for illustrative purposes only Likelihood Estimation 0% - 100% Size-adjusted for cross- company contrasts Standardized for longitudinal tracking Next, the severity of loss will be estimated, also in a larger competitive context The estimate will support firms’ classification in an appropriate damage level group, as illustrated below Severity Estimation $0 - $upper limit Size-adjusted for cross- company contrasts Standardized for longitudinal tracking Likelihood of Class Action LitigationExpected Severity of Loss

Risk Categorization: Likelihood x Severity Risk = Class Action Likelihood + Estimated Severity of Loss High Low High Low Overall largest likelihood & severity Overall smallest likelihood & severity MARA: Firm-Level Likelihood x Severity Tallying Overall moderate likelihood & severity LIKELIHOOD SEVERITY RISK TAKERSNORMATIVES RISK AVOIDERS Beecher Carlson’s Multivariate Algorithm for Risk Analysis—MARA— amalgamates the separately derived likelihood and severity profiles into a single risk categorization schema, as illustrated below:

User Benefits: Enterprise Risk Management Risk Characterization Available Data Methodological Considerations Risk Quantification Risk Likelihood Estimation Risk Severity Estimation Risk Tallying & Categorization On-Going Risk Management Risk Transference Drivers of Risk Delineation What-If Decision Planning Premium Differentiation Terms Determination

On-Going Enterprise Risk Management Decision Scenario 1 What—if? Decision Scenario 2 Decision Scenario n Scenario-attributable impact incrementality quantification Baseline Scenario 1 Lift Scenario 2 Lift Scenario n Lift The risk management advisory is supported by a quantitative scenario evaluation tool, the goal of which is to provide objective side-by-side comparisons of the expected risk impact of contemplated courses of action.

D&O Crisis Management Planning: Terrorist Attack Business Interruption attributable to weather-related events Disruption of IT and Communication systems by hackers or other causes Avian flu Major D&O claim emanating from securities-related issues Preparing for Barbarians at the Gate

Which of these events is likely to be the most cataclysmic for your company? How come very few companies have a crisis management plan for a D&O meltdown? D&O Crisis Management Planning: Preparing for Barbarians at the Gate

What are you looking to accomplish in structuring a D&O program? How do you balance the interests of the individuals with those of the company? How much coverage is enough? What does enough mean? What is your crisis management plan in the event of a major D&O claim? D&O Crisis Management Planning: Preparing for Barbarians at the Gate

Developing a Crisis Management Plan D&O underwriters Shareholders Banks and other Creditors Rating agencies Regulatory authorities Customers Suppliers Employees The first 24 hours Financial issues Restructuring the Board and replacing Executive Officers Dislocation among employees Brand restoration The damage created by Moving forward

Questions & Answers